You currently own 600 shares of JKL, Inc. JKL is an all equity firm that has 75,000 shares of stock outstanding at a market price of $40 a share. The company's earnings before interest and taxes are $140,000. JKL has decided to issue $1 million of debt at 8 percent interest. This debt will be used to repurchase shares of stock. How many shares of JKL stock must you sell to unlever your position if you can loan out funds at 8 percent interest? Ignore taxes.
HINT: You unwind leverage by holding debt and equity in the levered company that is proportional to the levered company's capital structure. Start by finding the new capital structure (debt-equity ratio) if the firm issues the debt.
You currently own 600 shares of JKL, Inc. JKL is an all equity firm that has 75,000 shares of stock outstanding at a market price of $40 a share. The company's earnings before interest and taxes are $140,000. JKL has decided to issue $1 million of debt at 8 percent interest. This debt will be used to repurchase shares of stock. How many shares of JKL stock must you sell to unlever your position if you can loan out funds at 8 percent interest? Ignore taxes.
HINT: You unwind leverage by holding debt and equity in the levered company that is proportional to the levered company's capital structure. Start by finding the new capital structure (debt-equity ratio) if the firm issues the debt.
Related questions
You currently own 1,300 shares of JKL, Inc. JKL is an all equity that has 300,000 shares of stock outstanding at a market price of $15 a share. The company's earnings before interest and taxes are $900,000. You believe that the JKL should finance 20 percent of assets with debt, but management refuses to leverage the company. Given that similar firms' pay 12 percent interest on their debt, answer the following questions.
| Part A: How much money should you borrow to create the leverage on your own? Assume you can borrow funds at 12 percent interest.
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| Part B: How many additional shares of JKL stock must you purchase (using the borrowed funds in Part A) to create the leverage on your own?
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| FCOJ, Inc., a prominent consumer products firm, is debating whether or not to convert its all-equity capital structure to one that is 40 percent debt. Currently, there are 6,500 shares outstanding and the price per share is $57. EBIT is expected to remain at $22,750 per year forever. The interest rate on new debt is 6 percent, and there are no taxes. |
| Required: |
| (a) | Melanie, a shareholder of the firm, owns 130 shares of stock. What is her cash flow under the current capital structure, assuming the firm has a dividend payout rate of 100 percent?
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| b) | What will Melanieâs cash flow be under the proposed capital structure of the firm? Assume that she keeps all 130 of her shares. |
| Shareholder cash flow | $ ___ |
| (c) | Suppose FCOJ does convert, but Melanie prefers the current all-equity capital structure. Show how she could unlever her shares of stock to recreate the original capital structure. Number of shares stockholder should sell ____ |
